On February 17, 2009,
President Barack Obama signed the American
Recovery and Reinvestment Act of 2009, P.L.
111-5, which created the American
opportunity tax credit (AOTC). Effective for
tax years 2009–2012, the AOTC provides for a
maximum tax credit of $2,500 (100% of the
first $2,000 of qualified expenses and 25%
of the next $2,000) (Sec. 25A(i)). Unlike
its predecessor, the Hope scholarship
credit, the AOTC is partially refundable up
to $1,000 (40% of $2,500) (Sec.
25A(i)(6)).

Nonresident
Aliens

Nonresident aliens have always
been ineligible for education tax credits
(unless married filing jointly with a U.S.
citizen or resident and electing to be
treated as a U.S. resident) (Sec.
25A(g)(7)). However, since the enactment of
the AOTC, this rule has taken on greater
importance. The tax compliance of
international students is now a more
critical issue because of the partially
refundable nature of the AOTC. If an
international student improperly files a
Form 1040, U.S. Individual Income Tax
Return, as a resident alien (instead of Form
1040NR, U.S. Nonresident Alien Income Tax
Return), the government stands to lose a
much greater amount than it did for the Hope
credit.

Who is considered a nonresident
alien? Sec. 7701(b)(1)(B) defines a
nonresident alien as someone who is not a
citizen or resident of the United States. An
alien qualifies as a resident by meeting
either the lawful permanent residence (green
card) test or the substantial presence test
(Sec. 7701(b)(1)(A)). To satisfy the
substantial presence test, an alien must be
present in the United States at least 31
days in the current year and 183 days during
the current and preceding two calendar tax
years. For purposes of the 183-day rule,
aliens count days of presence using the
formula provided in Sec. 7701(b)(3)(A)(ii),
as shown in Exhibit 1.

International Students

Are international students treated as
resident aliens? The answer depends on the
type of visa the student holds and the
length of time the student has been in the
United States. International students
generally enter the United States on an F
visa. Because a student studying in the
United States on an F visa is treated as an
exempt individual for purposes of counting
days of presence (Sec. 7701(b)(5)(D)), the
overwhelming majority of international
students are treated as nonresident aliens
while they are studying in the United
States. Thus, even though some students live
on campus in the United States for an entire
year, no days of presence count for purposes
of the substantial presence test. As a
result, if required to file a U.S.
individual income tax return, they must use
Form 1040NR (or 1040NR-EZ) as nonresident
aliens. The exempt individual “taint” lasts
for five years (Sec. 7701(b)(5)(E)(ii)).
Once individuals reach their sixth year in
the United States, they start counting their
days of presence.

Resident vs. Nonresident
Alien

While residents are taxed on
their worldwide income (Regs. Sec.
1.1-1(b)), nonresident aliens are taxed on
only their U.S.-source income (Sec. 871).
Although this rule may appear beneficial to
nonresidents, international students are
generally worse off because of their
ineligibility for certain tax credits and
deductions. Exhibit 2 illustrates
the difference between the taxation of
residents and of nonresidents for an
international student who works on
campus.

Conclusion

For 2011 and 2012 (or longer if the AOTC
is renewed), the government will risk losing
revenue if it does not improve its efforts
to insure compliance by international
students. At a time when the country is
running unsustainable budget deficits, the
government needs to take appropriate action
to close this potential tax gap. To avoid
lost revenue from incorrect returns, the
federal government should require colleges
and universities to identify international
students as residents or nonresidents for
tax purposes. The designation could simply
be an additional box on the Form 1098-T,
Tuition Statement. Unless a student provides
evidence to the contrary, universities could
assume that all international students are
nonresidents. If the nonresident box is
checked, the IRS could match the 1098-T to
the tax return to make sure the student has
properly filed a Form 1040NR. Although this
proposal would increase the burden on
institutions of higher education, it would
improve compliance among international
students without requiring substantial audit
efforts by the IRS.

EditorNotes

Mark Cook is a partner at SingerLewak LLP
in Irvine, CA.

The editor would like
to offer a special thanks to Christian J.
Burgos, J.D., LL.M., for his assistance with
this column.

For additional information about these
items, contact Mr. Cook at (949) 261-8600,
ext. 2143, or mcook@singerlewak.com.

Unless otherwise
noted, contributors are members of or
associated with SingerLewak LLP.

The winner of The Tax Adviser’s 2014 Best Article Award is James M. Greenwell, CPA, MST, a senior tax specialist–partnerships with Phillips 66 in Bartlesville, Okla., for his article, “Partnership Capital Account Revaluations: An In-Depth Look at Sec. 704(c) Allocations.”

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